1. What is corporate-level strategy? Why is corporate-level strategy important for a company seeking rapid growth?
Corporate-level strategy is about how and where a company, as a whole, competes. It is the master plan of a company and includes diversification, integration, mergers, and acquisition, turnaround, and retrenchment strategies. It is about the most critical long-run consideration, which is the development of organizational capability in deciding which parts of the value chain to engage in. This presents companies with one of their most difficult strategic decisions.
2. What are the merits of vertical integration? What are the differences between horizontal and vertical integration?
Vertical integration refers to a company’s ownership of vertically related activities. The greater the company’s ownership and control over successive stages of the
value chain for its product, the greater its degree of vertical integration. The extent of vertical integration is indicated by the ratio of a company’s value added to
its sales revenue. Highly integrated companies tend to have low expenditures on bought-in goods and services relative to their sales. Vertical integration can be
either backward, where the company takes over ownership and control of producing its components or other inputs, or forward, where the company takes over ownership
and control of activities previously undertaken by its customers.
Horizontal integration is a form of expansion by which a company expands its business activities by taking over or merging with another business in the same industry
and at the same level in the supply chain. A company can achieve horizontal growth through mergers and acquisitions of companies that offer similar products or
services.
3. What are the differences between a merger and an acquisition? When and why are they useful?
A merger is a transaction in which the assets of at least two companies are transferred to a new company so that only one separate legal entity remains. Acquisition is
a transaction in which both companies in the transaction can survive but the acquirer increases its percentage ownership in the target. The purchase of a company is called an acquisition when the target company ceases to exist, the new buyer takes in the business, and the buyer’s stock continues to be traded. However, a merger is when two companies agree to go forward as a single new company rather than remain separately owned and operated.
Mergers and acquisitions refer to the aspects of corporate-level strategy that deal with the buying, selling and combining of different companies that can help a company in a given industry grow rapidly without having to create another business entity.
4. Compare and contrast related and unrelated diversification. When will unrelated diversification be more useful?
There are two types of diversification. The first type, related diversification (or concentric diversification), is about the expansion of the business based on the common core of a company’s existing resources and capabilities. With related diversification, synergy increases because the related activity can increase value and the economies of scale can save money. Unrelated diversification (or conglomerate diversification) is used to improve the profitability and lower the overall business risk of a company.
Unrelated diversification is more useful when there is no common thread of strategic fit or relationship between the new and old lines of business; the new and old businesses are unrelated.
5. When is a retrenchment strategy necessary?
Retrenchment is a corporate-level strategy that seeks to reduce the size or diversity of an organization’s operations. It includes all activities involving the contraction of a company’s operations or changes in its assets or financial structure.
Retrenchment usually revolves around cutting costs. It enables senior managers of underperforming companies to understand the critical causes of poor results in order to stem losses and restore growth. A well-crafted retrenchment strategy leads companies to quickly achieve their full potential. This involves removing costs,
restructuring finances and redefining strategic objectives.
Discussion Questions
1. An ice cream manufacturer is proposing to acquire a soup manufacturer on the basis that, first, its sales and profits will be more seasonally balanced and, second, from year to year, sales and profits will be less affected by variations in weather. Will this spreading of risk create value for shareholders? Under what circumstances could this acquisition create benefits for shareholders?
The acquisition of a new business is complex and fraught with peril. The best acquisitions follow a structured and disciplined approach, with clear strategic objectives, detailed implementation plans, and a focus on creating and capturing value. Whether the acquisition will create value depends on the following:
(a) where real economies can be gained by merging the two businesses. Thus, if employees can be redeployed between ice cream and soup production and if certain functions (e.g. distribution, HR, accounts, and finance) can be combined, then the merger might boost the cash flows of each business.
(b) As long as the cash flows of the individual businesses are unaffected by the merger, less variability does not create value for owners. If the two businesses are public companies, then shareholders can undertake their own risk reduction through holding portfolios of different companies’ stocks.
(c) As long as the cash flows of the individual businesses are unaffected by the merger, less variability does not create value for owners. If the two businesses are public companies, then shareholders can undertake their own risk reduction through holding portfolios of different companies’ stocks.
2. Tata Group is one of India’s largest companies, employing 203 000 people in many different industries, including steel, motor vehicles, watches and jewelry, telecommunications, financial services, management consulting, food products, tea, chemicals and fertilizers, satellite TV, hotels, motor vehicles, energy, IT and construction. Such diversity far exceeds that of any North American, western European, or Australian company. What are the conditions in India that might make such broad-based diversification both feasible and profitable?
Tata Group lacks close operational linkages between its businesses – they are simply too diverse. Tata Group adds value by allocating investment funds and personnel between its different businesses, deploying its top management expertise, and establishing and developing new businesses. The essential condition for this to work is that Tata needs to be more efficient in managing these processes than external markets. In the US and UK, conglomerate firms no longer have any general advantage in allocating investment funds, motivating business managers, or starting up new businesses – all these functions are performed efficiently by the capital markets. In India, capital markets are less efficient, venture capital is less developed, and labor markets for managers and other skilled professionals are less developed. In these circumstances, not only is Tata able to utilize internal information and sophisticated decision-making systems to allocate resources more effectively than external markets, but it may also benefit from lower resource costs (in particular, a lower cost of capital than smaller, more specialized companies).
Apart from financial and human resources, other resources that Tata can deploy across its different businesses are influence and business relationships. In a highly regulated country like India, political influence is critically important. Tata’s size and diversity undoubtedly give it considerable power within both state and federal governments. Its international network of relationships also allows it to be a preferred joint venture partner for foreign multinationals seeking to invest in India.
3. Giorgio Armani is an Italian private company owned mainly by the Armani family. Most of its clothing and accessories are produced and marketed by the company (some are manufactured by outside contractors). For other products, notably fragrances, cosmetics, and eyewear, Armani licenses its brand names to other companies. Armani is considering expanding into athletic clothing, hotels, and bridal shops. Advise Armani on whether these new businesses should be developed in-house, by joint ventures, or by licensing the Armani brands to specialist companies already within these fields.
In choosing between licensing, joint venture, or wholly owned diversifications, the key criteria are likely to be:
• The transaction costs associated with licensing Armani’s brand: If licensing contracts can be easily written and easily enforced, then licensing represents a viable and attractive strategy for exploiting these markets. However, if there are risks from licensees oversupplying the market, supplying products that are not consistent with Armani’s image and quality, or undermining Armani’s reputation in any other way, then licensing may be risky.
• The opportunities for sharing or transferring Armani’s other resources and capabilities with/to the new businesses: Apart from its brand, which of Armani’s other resources and capabilities can be utilized in the new business? In the case of bridal clothing and accessories, Armani can probably utilize its existing design, manufacturing, marketing, and distribution capabilities – in which case Armani can develop this business in-house. In the case of athletic clothing and equipment, Armani may need to access the technical capabilities needed to design products for different sports – hence, a joint venture may be appropriate. In the case of hotel management, it is not apparent that any of Armani’s resources and capabilities (other than its brand) relate to the design and operation of luxury hotels – hence, licensing may be the best solution.
4. With reference to a diversified conglomerate in Australia (e.g. Wesfamers), discuss why diversification is a good choice for a company at the mature stage of its
business.
Companies can take a variety of corrective actions during the maturity stage in order to start a new development cycle or at least to stave off going out of business.
Beginning in the maturity stage companies can bypass decline by focusing on product or service positions and implementing new methods of attracting and retaining
customers. To promote new growth, companies also must attempt to introduce a diversification strategy.
As a company matures, it must focus more and more on external factors that can lead to decline. If a company fails to take the initiative during the maturity stage, it
may face an even more formidable task of trying to reverse its descent later on. Furthermore, if companies anticipate maturation and implement policies that will help
them become more diversified during this stage, they can reduce the effects of the maturity stage and more easily spark a new start-up or growth stage.
Maturity and decline tend to result from companies becoming habituated to doing business a certain way during the start-up and growth stages and being unable to break
these business habits when they cease to be fruitful. If a business strategy has been successful, companies tend not to make changes until it is too late, until they
start to decline. To avoid losing ground, companies should maintain a marketing attitude, which entails determining customer needs and wants and striving to meet them.
5. Zara manufactures close to half of the clothes sold in its retail stores and undertakes all of its own distribution from manufacturing plants to retail outlets. Gap
outsources production and distribution. Should Zara outsource its manufacturing and distribution? Should Gap backward integrate into production and distribution? Why?
Zara – like American Apparel – is an interesting and unusual example of a vertically integrated fashion clothing company. The dominant model in fashion clothing is for
retailing and manufacturing to be undertaken by different companies. Thus, Gap does its own design, but its manufacturing is undertaken by contractors, mostly in
Southeast Asia. The advantages of this system are:
• It avoids the problem of managing manufacturing plants far away from the retailers’ retail operations and corporate head offices.
• Retailing and manufacturing are strategically dissimilar – different capabilities, and different optimal scales.
• It offers flexibility to both sides in adapting to uncertainty. Retailers can shift sourcing according to the costs and exchange rates. Manufacturers can hedge
risk by supplying different retailers.
Zara has succeeded by creating a vertically integrated system where the disadvantages of vertical integration (higher costs of manufacturing in Europe, lack of
flexibility in shifting plant locations, etc.) are offset by the unprecedented speed and design flexibility that is tightly coordinated vertical system permits. Thus,
Zara’s highly compressed product development cycle would be impossible for Gap or any other retailer relying on contract manufacturers in Southeast Asia. Zara’s
vertical integration works for Zara because it fits with other aspects of its strategy: mid-market pricing, high-fashion orientation, and constantly changing product
range. For Gap, vertical integration probably would not work: its pricing is relatively low (hence, it needs to produce in low-wage countries), it does not have
manufacturing experience, and its products tend to be basic staples (jeans, T-shirts, khaki pants, and shorts) such that seasonal product changes are adequate to keep
abreast of changing market preferences.
Exercises
1. Form a group of three to four members with your peers. Identify a company that has recently undertaken some major changes in its operations (e.g. major takeover or
restructuring). Assess the characteristics of such changes and analyze whether they were successful or not.
Examples of takeover and restructuring can be found in the following strategy capsules:
Strategy capsule 8.1 Synlait: a new kind of dairy business
Strategy capsule 8.2 NEC Australia changes its strategy
Strategy capsule 8.3 Fujitsu Australia expands by acquisition
Strategy capsule 8.4 The multi-billion dollar merger between Vodafone and Hutchison
Strategy capsule 8.5 What can be learned from Kmart’s turnaround and retrenchment strategy
2. Collect information on at least five large companies in Australia (BHP Billiton, Rio Tinto, Telstra etc.). Identify recent examples of strategies of these companies
that are related to mergers, acquisitions, diversification, and vertical and horizontal integration.
Examples of large companies in Australia:
BHP Billiton, AMP Limited, National Australia Bank Ltd., Woolworths Ltd, Coles Myer Ltd, Telstra Corp Ltd, Commonwealth Bank of Australia, ANZ Australia & New Zealand
Banking Group Ltd, Qantas, Lend Lease Corp. Ltd.,
3. Write a short essay (750–1000 words) on the importance of formulating an appropriate corporate-level strategy. What are the possible options for such formulation?
Unlike business-level strategy, which is primarily concerned with how business units of a company compete within specific markets, corporate-level strategy is about how
and where a company, as a whole, competes. There are various aspects that influence corporate-level strategy, including product scope (diversification), vertical scope
(vertical integration), and geographical scope (multinational). Students are advised to consider these issues carefully.
Web Exercises
1. Identify some major merger or acquisition cases from the past few years. Evaluate the success of such cases and analyse whether they have achieved their objectives.
Examples of major merger or acquisition cases can be found in the following strategy capsules:
Strategy capsule 8.3 Fujitsu Australia expands by acquisition
Strategy capsule 8.4 The multi-billion dollar merger between Vodafone and Hutchison
2. Explore the Australian Competition and Consumer Commission (ACCC) website, www.accc.gov.au. Discuss why the Australian government pays so much attention to mergers
and acquisitions in Australia?
Mergers and acquisitions refer to the aspects of corporate-level strategy that deal with the buying, selling and combining of different companies that can help a
company in a given industry grow rapidly without having to create another business entity. They are closely related to an integration strategy.
Despite the goal of performance improvement, results from mergers and acquisitions are often disappointing. Numerous empirical studies show high failure rates of
mergers and acquisition deals.Mergers and acquisitions very often cause social concern. For example, the ACCC showed concern when the Commonwealth Bank of Australia
acquired Bankwest. The concern was primarily related to the fear of reducing competition in the banking business in Australia.
3. ‘Don’t put all of your eggs in one basket!’ You’ve probably heard that over and over again throughout your life. Are companies following this premise? Investigate
the diversification strategy of some major companies and assess to what extent they are successful.
A motive for diversification is the desire to spread risks. So long as the cash flows of the different businesses are imperfectly correlated, then the variance of the
cash flow of the combined businesses is less than the average of that of the separate businesses. Hence, diversification reduces risk.
Risk spreading through diversification may benefit other stakeholders. If cyclicality in the company’s profit is accompanied by cyclicality in employment, then so long
as employees are transferable between the separate businesses of the company, there may be benefits to employees from diversification’s ability to smooth output
fluctuations.
Special issues arise when considering the risk of bankruptcy. For a marginally profitable company, diversification can help avoid cyclical fluctuations of profits that
can push it into insolvency. If there are economies to the company from financing investments internally rather than resorting to external capital markets, the corporate level strategy stability in the company’s cash flow that results from diversification may reinforce independence from external capital markets.
